United States Court of Appeals
For the First Circuit
No. 05-1631
WATERPROOFING SYSTEMS, INC.,
Plaintiff, Appellee,
v.
HYDRO-STOP, INC.,
Defendant, Appellant.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF PUERTO RICO
[Hon. Camille Vélez-Rivé, U.S. Magistrate Judge]
Before
Torruella, Circuit Judge,
Campbell, Senior Circuit Judge,
and Lipez, Circuit Judge.
Rafael Escalera-Rodríguez, with whom Thomas J. Trebilcock-
Horan, Alberto R. López-Rocafort, and Reichard & Escalera were on
brief, for appellant.
Stuart A. Weinstein-Bacal, with whom Liana Colón-Valentín and
Weinstein-Bacal & Miller, P.S.C. were on brief, for appellee.
March 2, 2006
TORRUELLA, Circuit Judge. Appellant Hydro-Stop, Inc.
("Hydro-Stop") appeals from an order granting a preliminary
injunction in favor of Appellee Waterproofing Systems, Inc.
("Waterproofing") under the Puerto Rico Dealers Act, Law 75 of
June 24, 1964, 10 P.R. Laws Ann. §§ 278-278d ("Law 75"), enjoining
Hydro-Stop from terminating their exclusive distribution agreement
("Distribution Agreement").
On November 5, 2004, Waterproofing filed a complaint in
the United States District Court for the District of Puerto Rico
alleging that Hydro-Stop's unilateral termination of their
Distribution Agreement violated Law 75 because it was without "just
cause," and requesting a Temporary Restraining Order ("TRO") to
compel the continuation of their business relationship.
The district court judge referred the case to the
magistrate judge, and the parties consented to the magistrate's
jurisdiction over any and all proceedings in accordance with Rule
73 of the Federal Rules of Civil Procedure.1 On February 17, 2005,
1
Rule 73 provides:
a) Powers; Procedure. When specially designated to
exercise such jurisdiction by local rule or order of the
district court and when all parties consent thereto, a
magistrate judge may exercise the authority provided by
Title 28, U.S.C. § 636(c) and may conduct any or all
proceedings, including a jury or nonjury trial, in a
civil case.
. . .
c) Appeal. In accordance with Title 28, U.S.C. § 636
(c)(3), appeal from a judgment entered upon direction of
a magistrate judge in proceedings under this rule will
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after evidentiary hearings, the magistrate entered an Opinion and
Order granting the preliminary injunction on the ground that Hydro-
Stop had terminated the Distribution Agreement without just cause.
On March 3, 2005, Hydro-Stop filed a Motion Requesting
Reconsideration and/or to Alter or Amend Judgment pursuant to Rule
52(b) of the Federal Rules of Civil Procedure. On March 8, the
magistrate denied the motion, and on March 28, 2005 Hydro-Stop
filed a Notice of Interlocutory Appeal to this court. After
careful consideration, we affirm.
I.
Waterproofing has been in the business of distributing
roof sealants and waterproofing products in Puerto Rico since 1997.
In 1999, Waterproofing began to distribute Hydro-Stop's products in
Puerto Rico pursuant to a verbal agreement between the two
companies. On January 1, 2000, Hydro-Stop and Waterproofing
entered into the Distribution Agreement which designated
Waterproofing as Hydro-Stop's exclusive distributor in Puerto Rico.
Until Hydro-Stop terminated the Distribution Agreement in
March 2004, Waterproofing was responsible for all sales of Hydro-
Stop products in Puerto Rico. Waterproofing consistently exceeded
the annual sales quotas set forth in the Distribution Agreement,
and for the past five years Waterproofing has had higher sales than
lie to the court of appeals as it would from a judgment
of the district court.
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any other Hydro-Stop distributor in the world. During the past
five years, Hydro-Stop has earned profits of at least $1.5 million
from Waterproofing's sales.
As part of their ordinary business relationship, Hydro-
Stop normally extended credit to Waterproofing for the purchase of
Hydro-Stop products. When Waterproofing's debt reached $200,000 in
2001, Hydro-Stop advised that it would extend no further credit
until the debt was repaid. In order to pay down the debt,
Waterproofing agreed to pay a "premium" of $15 per pail of Hydro-
Stop product, and by early 2003, the outstanding debt had been
reduced to $35,000. In late 2002 or early 2003, Hydro-Stop
reinstated the credit line available to Waterproofing, up to a
limit of $100,000.
At a meeting held on or about November 5, 2003 in
Charleston, South Carolina, Hydro-Stop advised Waterproofing of its
intent to abrogate the exclusivity of the Distribution Agreement
and to distribute Hydro-Stop products directly in Puerto Rico.
Waterproofing objected, but Hydro-Stop began making direct sales of
its products in Puerto Rico, at discounted prices and with credit
terms that Waterproofing could not match. Hydro-Stop's direct
sales yielded nearly twice the gross profits as those in which
Waterproofing served as intermediary.
In late 2003, when Waterproofing had reached its $100,000
credit limit, it advised Hydro-Stop of a profitable opportunity to
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contract with Promo Export, an agency of the Government of Puerto
Rico ("Promo Export Project"). Hydro-Stop would provide the
materials, and Waterproofing would provide the labor to complete
the job. Hydro-Stop advanced Waterproofing a total of $69,200.50
for materials necessary for Phases I and II of the three-phase
project. To guarantee that Hydro-Stop would be repaid, the three
parties entered into an agreement, pursuant to which Promo Export
was to issue joint checks payable to both Waterproofing and Hydro-
Stop for the work performed for the Promo Export Project ("Joint
Check Agreement").
On or about March 2, 2004, upon the completion of Phase
I, Promo Export issued the first check, payable jointly to Hydro-
Stop and Waterproofing, in the amount of $88,590.60. Waterproofing
President Luis Esteves IV ("Esteves") endorsed the check with
Waterproofing's name and Hydro-Stop's name and deposited it in
Waterproofing's account in Puerto Rico. On March 8, 2004, Esteves
obtained a manager's check from Westernbank in Puerto Rico, payable
jointly to Hydro-Stop and Waterproofing, in the amount of
$66,442.95. Esteves sent the check to Hydro-Stop with a letter,
dated March 5, 2004, authorizing Hydro-Stop to cash the check.
In a letter dated March 11, 2004, Hydro-Stop informed
Waterproofing that it was terminating the Distribution Agreement
because Waterproofing had "misappropriated $22,147.65 of money that
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rightfully belongs to Hydro-Stop, Inc. based upon [the] joint check
agreement with Promo Export."
II.
We have jurisdiction to hear interlocutory appeals of
preliminary injunction orders under 28 U.S.C. § 1291(a)(1). In our
review of preliminary injunctions, "we scrutinize abstract legal
matters de novo, findings of fact for clear error, and judgment
calls with considerable deference to the trier." Re-Ace, Inc. v.
Wheeled Coach Indus., Inc., 363 F.3d 51, 55 (1st Cir. 2004)
(internal citation and quotation marks omitted).
A. Just Cause
Puerto Rico Law 75 was enacted specifically to "remedy
the abusive practices of suppliers who arbitrarily eliminated
distributors after they had invested in the business and had
successfully established a market in Puerto Rico for the supplier's
product or service." Triangle Trading Co. v. Robroy Indus, Inc.,
200 F.3d 1, 2 (1st Cir. 1999) (internal citation and quotation
marks omitted). Accordingly, Law 75 provides that "no principal or
grantor may directly or indirectly perform any act detrimental to
the established relationship . . . except for just cause." 10 P.R.
Laws Ann. § 278a.
The critical issue in this case is whether Hydro-Stop had
"just cause" to terminate the Distribution Agreement. Law 75
provides that just cause is
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[n]onperformance of any of the essential
obligations of the dealer's contract, on the
part of the dealer, or any action or omission
on his part that adversely and substantially
affects the interests of the principal or
grantor in promoting the marketing or
distribution of the merchandise or service.
10 P.R. Laws. Ann. § 278(d) (emphasis added).
Hydro-Stop alleges two separate grounds to support its
claim of just cause: Waterproofing's consistent failure to make
timely payments, and the alleged fraud and breach of trust arising
from Waterproofing's endorsement and deposit of the Promo Export
check. We will deal with each in turn, bearing in mind that the
issue of just cause under Law 75 is a question of fact reviewable
for clear error. See R.W. Int'l Corp. v. Welch Foods, Inc., 88
F.3d 49, 51 (1st Cir. 1996).
During the course of their business relationship,
Waterproofing was often late in its payments to Hydro-Stop, and the
magistrate concluded that because Hydro-Stop had not previously
terminated the Distribution Agreement because of late payment, it
could not suddenly change course without violating the principle
enshrined in Law 75. In short, the magistrate held that "what was
not just cause then is not just cause now." We find this
conclusion troubling.
This court has held that "paying for goods on time
normally is one of the essential obligations of the dealer's
contract," the non-fulfillment of which can constitute just cause
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under Law 75. PPM Chemical Corp. of Puerto Rico v. Saskatoon
Chemical Ltd., 931 F.2d 138, 139 (1st Cir. 1991) (internal citation
and quotation marks omitted). However, we have recognized an
exception in those unusual cases where "a supplier does not care
about late payments." Id.; see also Biomedical Instrument and
Equip. Corp. v. Cordis Corp., 797 F.2d 16, 18 (1st Cir. 1986).
Waterproofing alleges -- and the magistrate seems to have agreed --
that Hydro-Stop did not care about Waterproofing's late payments,
and thus that the late payments did not constitute just cause for
termination of the Distribution Agreement.
For its part, Hydro-Stop alleges that Waterproofing's
persistent cash flow problems led to a pattern of continuously late
payments during the course of their relationship, and that it was
forced to go to great lengths in order to keep Waterproofing
afloat, including extending credit, creating payment plans, and
granting special concessions. At one point, Hydro-Stop President
Nicholas Causey ("Causey") made a personal loan of $80,000 to
Waterproofing's vice president so that Waterproofing could pay off
some of its outstanding debt.
These efforts indicate that far from "not caring" about
the payment schedule, Hydro-Stop was in fact actively engaged with
the project of trying to reduce Waterproofing's ever-growing debt.
It may well be that Hydro-Stop was willing to overlook the untimely
payments because of Waterproofing's successful sales records for
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the first four years of their relationship. However, we think it
quite possible that there was a limit to the supplier's patience.
In March 2004, when Hydro-Stop unilaterally terminated the
Distribution Agreement, Waterproofing owed Hydro-Stop more than
$120,000. Despite the fact that the payment term was then 60 days,
more than $30,000 had been outstanding for longer than that period.
The magistrate would have us hold that while Waterproofing's
indebtedness in March 2004 might have constituted just cause if it
had been the first such occurrence, it could not legitimately have
been the proverbial straw to break the camel's back. We disagree.
It is contrary to the principle enshrined in Law 75 to require that
suppliers terminate distribution agreements immediately upon
distributors' failure to pay timely, or risk being forever banned
from so doing. Such a result would discourage efforts on the part
of suppliers to reach creative solutions to enable the success of
long-term relationships with distributors in Puerto Rico.
Despite our disagreement with the magistrate's disposal
of Hydro-Stop's claim of just cause on the basis of
Waterproofing's failure to pay timely, our standard of review is
for clear error, which we do not find here. Although we can
imagine a situation in which a distributor does not take action to
terminate its relationship with a supplier for late payments until
many such occurrences have genuinely exhausted its patience, there
is sufficient evidence on the record to support the magistrate's
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conclusion that this was not such a situation. Despite Hydro-
Stop's allegations to the effect that Waterproofing "continuously"
failed to make timely payment during the course of their business
relationship, in a letter dated March 2002, Causey congratulated
Waterproofing on an "extraordinary job . . . [F]or the second year
in a row Waterproofing Systems is at the top of the list of all our
distributors in total sales." We find no hint of dissatisfaction
in those words. And in November 2003, when Hydro-Stop first
informed Waterproofing of its intention to abrogate the exclusivity
of the Distribution Agreement so that it could distribute Hydro-
Stop products directly in Puerto Rico, Waterproofing was within its
credit limit and current in its payments. In that month, despite
Waterproofing's rejection of the proposed change and without its
knowledge, Hydro-Stop -- through its own agent in Puerto Rico --
began making direct sales of its products to Waterproofing's
customers, at discounted prices and with credit terms that
Waterproofing could not match. Furthermore, Hydro-Stop's agent
advised some of Waterproofing's customers that Waterproofing was no
longer Hydro-Stop's distributor in Puerto Rico. Hydro-Stop's
incentive was clear -- its direct sales yielded double the gross
profits that Waterproofing's sales brought in. It was in this
context that Waterproofing first approached Hydro-Stop with the
Promo Export Project proposal. After hearing testimony from both
parties, the magistrate credited Waterproofing's theory that Hydro-
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Stop's claim of just cause on the basis of late payments was merely
a pretext for abrogating the Distribution Agreement. We find no
reason to upset the lower court's determination.
Hydro-Stop also alleges just cause to terminate the
Distribution Agreement because of Waterproofing's endorsement and
deposit of the Promo Export check, and subsequent retention of
funds. The magistrate found that it was common practice between
the parties for Waterproofing to accept and deposit checks issued
to both companies and to remit payment to Hydro-Stop, and thus that
such action with regard to the Promo Export check was not
fraudulent. On appeal, Hydro-Stop contends that this finding is
not supported by the record and constitutes "clear error." Hydro-
Stop's argument to this end proceeds in three parts: first that
Waterproofing's endorsement and deposit of the Promo Export check
was illegal under Puerto Rico Law; next that Waterproofing's
actions breached the Joint Check Agreement; and finally that
Waterproofing's breach of the Joint Check Agreement was in bad
faith, thus constituting just cause for terminating the
Distribution Agreement.
Hydro-Stop contends Waterproofing's endorsement of the
Promo Export check violated Puerto Rico Law. Under the Law of
Negotiable Instruments,
If an instrument is payable to two or more
persons alternatively, it is payable to any of
them and may be negotiated, discharged, or
enforced by any or all of them in possession
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of the instrument. If an instrument is
payable to two or more persons not
alternatively, it is payable to all of them
and may be negotiated, discharged, or enforced
only by all of them. If an instrument payable
to two or more persons is ambiguous as to
whether it is payable to the persons
alternatively, the instrument is payable to
the persons alternatively.
19 P.R. Laws Ann. § 510(d) (emphasis added). Hydro-Stop maintains
that, under the Joint Check Agreement, neither party could
unilaterally endorse and deposit the Promo Export check. However,
Hydro-Stop does not allege that the check itself was payable to
Hydro-Stop and Waterproofing "not alternatively." Thus, we must
conclude that the instrument was ambiguous as to this point, and by
law such an instrument "may be negotiated, discharged, or enforced
by any or all of them in possession of the instrument." Id.
Hydro-Stop next contends that Waterproofing breached the
Joint Check Agreement in two separate ways – both by unilaterally
endorsing and depositing the Promo Export check, and also by
retaining some of the funds in its own account. The Joint Check
Agreement, signed by Promo Export, Waterproofing, and Hydro-Stop,
provides that,
As security for payment of amounts due from
Waterproofing Systems to Hydro-Stop, Inc.
(Manufacturer), for materials supplied to
Waterproofing Systems and Promo Export
(Owner/Contractor) agree that all payments
from Promo Export (Owner/Contractor) to
Waterproofing Systems in connection with
Project Centro Mercantil Internacional, San
Juan, PR, (Project) will be made by check
issued jointly payable to Waterproofing
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Systems and Hydro-Stop, Inc. Waterproofing
Systems and Promo Export (Owner/Contractor)
agree that the total value of such payments
will be at least $246,085.00. Waterproofing
Systems acknowledges that it remains fully
liable to Hydro-Stop for payment for materials
to the extent Hydro-Stop, Inc. has not
received payment for this agreement.
On its face, the Joint Check Agreement requires merely
that all checks from the Promo Export project be "jointly payable"
to both parties. It is silent as to the question of whether either
party was prohibited from unilaterally endorsing and depositing
such checks. The magistrate looked to the customary practice of
the parties and found "credible evidence" that this very sequence
of events had been repeated at least one hundred times during the
course of their relationship.2 The magistrate further found that
"[Hydro-Stop's president] never voiced an objection [to the
practice] as long as Hydro-Stop was paid by Waterproofing." It is
difficult to understand why, if Hydro-Stop wanted to see an end to
this practice, it was not specifically addressed in the Joint Check
Agreement or another agreement between the parties.
Hydro-Stop also maintains that Waterproofing violated the
Joint Check Agreement by retaining some of the funds derived from
2
Hydro-Stop raises for the first time on appeal an argument that
the magistrate should not have considered evidence pertaining to
the general practice of the parties because such evidence was
extrinsic and barred by the Puerto Rico Parol Evidence Rule. We do
not address this argument because "[t]heories not raised in the
district court cannot be raised for the first time on appeal."
Tobin v. Liberty Mut. Ins. Co., 433 F.3d 100, 105 n.3 (1st Cir.
2005).
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the Promo Export check. Hydro-Stop insists that the entirety of
the difference between the amount of the Promo Export check and the
amount of the Westernbank manager's check -- $22,147.65 --
constituted misappropriated funds. By contrast, the magistrate
found that the amount of the manager's check was only $2,757.55
less than the total amount -- $69,200.50 -- Waterproofing owed
Hydro-Stop for materials used in both Phase I and II despite the
fact that the Promo Export check was payment for Phase I only. In
other words, Waterproofing claims -- and the magistrate agreed --
that the manager's check actually reflected a seven-month advance
payment to Hydro-Stop for materials used in Phase II. The Joint
Check Agreement provides only that Waterproofing "remains fully
liable to Hydro-Stop for payment for materials." Nowhere in the
Joint Check agreement or in any other written agreement before this
Court is there any provision as to the payment schedule for the
remainder of the proceeds from the Promo Export project. As
evidence that Waterproofing misappropriated more than $20,000,
Hydro-Stop merely directs our attention to the testimony of Causey
and co-owner, Richard Daniel ("Daniel"), who attested to Hydro-
Stop's interpretation of the Joint Check Agreement, according to
which Waterproofing was obligated to sign each check received from
the Promo Export project and physically send the signed instrument
to Hydro-Stop for deposit in Hydro-Stop's account. Hydro-Stop
fails to develop any argument that might enable us to find error in
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the magistrate's decision with regard to the alleged
misappropriation.
Hydro-Stop next contends that Waterproofing's retention
of funds from the Promo Export check was in bad faith.3 Under
Puerto Rico law, there is dolus, or "bad faith" when a party has
demonstrated "willful and voluntary failure to comply with [a legal
obligation] knowing that he is carrying out an unfair act."
Canales v. Pan American, No. R-81-12 R-80-318, 1982 WL 210645 (P.R.
Mar. 18, 1982) (trans). Hydro-Stop alleges that Esteves acted in
bad faith when he "unilaterally decided to fraudulently endorse"
the Promo Export check and then "attempt[ed] to conceal" his
actions. As evidence, Hydro-Stop points to Esteves's admission
that after endorsing and depositing the Promo Export check, he
purchased a manager's check from Westernbank in Puerto Rico, made
payable to both Hydro-Stop and Waterproofing, which he then
endorsed and sent to Hydro-Stop. From this, Hydro-Stop concludes
that Esteves willingly and knowingly violated his legal obligation,
contending that "[t]he intent was obvious, to pass off Westernbank
Manager's Check as the Promo Export check." The threshold inquiry
in determining whether Esteves acted in bad faith is whether he
failed to comply with a legal obligation. Because we find that he
was neither prohibited from endorsing and depositing the check nor
3
Hydro-Stop also alleges fraud but does not develop this argument
and so we do not consider it. Sunoco, Inc. v. Makol, 372 F.3d 31,
38 (1st Cir. 2004).
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obligated to remit the totality of the proceeds to Hydro-Stop, we
find that he could not have acted in bad faith.
B. Preliminary Injunction
Because this is a diversity case, the substantive law of
Puerto Rico applies. DeMoss v. Kelly Services, Inc., 493 F.2d
1012, 1015 (1st Cir. 1974); see also Erie R.R. Co. v. Tompkins, 304
U.S. 64, 78 (1938). Under Article 3A of the Puerto Rico Dealer's
Act, in any case involving the termination of a "dealer's
contract,"
the court may grant, during the time the
litigation is pending solution, any
provisional remedy . . . ordering any of the
parties, or both, to continue in all its
terms, the relation established by the
dealer's contract, and/or to abstain from
performing any act or any omission in
prejudice thereof. In any case in which the
provisional remedy herein provided is
requested, the court shall consider the
interests of all parties concerned and the
purposes of the public policy contained in
this chapter.
10 P.R. Laws Ann. § 278b-1 (emphasis added). Under Law 75, a
preliminary injunction is available to order parties to continue
their business relationships under existing distribution agreements
pending litigation. Re-Ace, 363 F.3d at 54-55. A preliminary
injunction under this statutory provision "is not tied to a showing
of irreparable injury or to probability of success in the case on
the merits, but rather to the policies of the Act in promoting the
continuation of dealership agreements and the strict adherence to
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the provisions of such agreements." DeMoss, 493 F.2d at 1015; see
also Luis Rosario, Inc. v. Amana Refrigeration, Inc., 733 F.2d 172,
173 (1st Cir. 1984).
The fundamental "public policy of the Act is to prevent
dealer termination without just cause." Luis Rosario, 733 F.2d at
173 (internal citation and quotation marks omitted). Having found
that public policy considerations militate in favor of the
continued operation of the Distribution Agreement, we turn to the
interests of the parties to determine whether a preliminary
injunction is appropriate. Hydro-Stop is an international company
with annual revenues of more than $7.5 million annually, whose
revenues have steadily increased since it entered into the
Distribution Agreement with Waterproofing, in large part because of
the latter's success in creating a market for Hydro-Stop products
in Puerto Rico. By contrast, Waterproofing is a small, closely
held family business which relies almost exclusively on its sale of
Hydro-Stop products. Since Hydro-Stop began selling its products
directly to Waterproofing clients in Puerto Rico, Waterproofing has
been forced to lay off 127 employees. The magistrate found that
Hydro-Stop's actions have already clearly and unequivocally harmed
Waterproofing's reputation in Puerto Rico. We accord considerable
deference to the magistrate's judgment that the balance of the
parties' interests with regard to a preliminary injunction favors
Waterproofing. Although the traditional common law test for a
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preliminary injunction does not apply here, we have found that "the
court's view of the merits would certainly affect its judgment of
the weight of the parties' interests and of the injunction's effect
on the statutory policies." Pan Am. Computer Corp. v. Data Gen.
Corp., 652 F.2d 215, 217 (1st Cir. 1981). The magistrate found
that there was a "substantial likelihood of success on the merits"
at trial to justify a preliminary injunction in favor of
Waterproofing, and we find no fault with that assessment.
III.
Because we have found no error in the magistrate's
determination that Hydro-Stop terminated the Distribution Agreement
without just cause, we find that the preliminary injunction was
properly granted.
Affirmed.
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